🛍️Business Overview

Total: 7/17

• +1 ✅ Projected Operating Margin: 16.15%
• +1 ✅ Projected 5-Year Revenue CAGR: 10.89%
• +1 ✅ Last 5-Year ROIC: 10.00%
• +1 ✅ Estimated Cost of Capital: 9.26% (lower than ROIC)
• -1 ❌ Last 5-Year Shares Outstanding CAGR: +1.26%
• +1 ✅ Projected 5-Year EPS CAGR: 16.89%
• +0 ⚠️ Projected 5-Year Dividend CAGR: N/A
• +1 ✅ Moody’s Debt Rating: A1
• +2 ✅✅ Morningstar Moat: Wide
• +0 ⚠️ Morningstar Uncertainty: Medium

📈Amazon transformed retail. Its solid operating margins (above ~10%) reflect more the other growing higher margin segments (cloud – AWS) rather than the lower margin business that is retail. This may accentuate during the next couple of years, increasing its overall margins. The fact that it also shows solid revenue and EPS growth above 10% is also nice to see.

📉The fact that the company is dilluting its shareholders by growing its shares outstanding can boost the company’s growth but its also something to keep an eye on during the next couple of years, assuring that eventually this stops and maybe starts implementing some share buybacks to return value to its shareholders. Another thing to watch out for is the difference between its ROIC and estimated cost of capital, they are both very close, meaning that the company may be struggling to earn more on its invested capital than its required.

Let’s do a valuation of Amazon, to check if its current market price is justified.

📝Business Valuation

To calculate the intrinsic value of the company I’ll use multiple methods:

• Discounted Cash Flows (DCF) – Intrinsic value is estimated by projecting its free cash flows over the next 10 years and discounting them to present value using the estimated cost of capital;
• EPS Growth – the fair value is estimated by projected the Earnings Per Share CAGR for the next 5 Years and then, given its current and historic values of PE, come up with a PE for the 5th Year. This will give us its price 5 Years from now using the formula: Price = EPS x PE that we then discount using the estimated cost of capital;
• Historical EV/EBITDA – we assume mean reversion to the historical EV/EBITDA values;
• Historical P/CF – we assume mean reversion to the historical P/CF values;
• Historical P/S – we assume mean reversion to the historical P/S values;
• Historical P/B – we assume mean reversion to the historical P/B values.

Cost of Capital

I’ve used the latest annual financial statement of the company, the 10-Year US bonds as the risk free rate and revenue geographic exposure to come up with its cost of capital, cost of debt and cost of equity. Also, given the fact that Moody’s provided a rating for the company I used it as the debt rating.

Cost of Capital: 9.26%.

This value will be used later as a discount rate in the valuation methods.

Please feel free to come up with your own values by using the tool I’ve used: Cost of Capital – The Fair Value Journal. It is and will ever be completely free 🙂

Discounted Cash Flows (Weight: 40%)

I’ve used the latest annual financial statement of the company, the analyst estimates for both revenue and margins and the cost of capital calculated previously.

Some notes on the inputs above:

• Terminal Revenue Growth – I’m using the risk-free rate (10-Yr bonds of the US), because long term the company should not grow more than the rate of the economy. I’m using the risk-free rate as a proxy to it, so the terminal growth becomes it;
• Terminal Cost of Capital – I’m assuming its Cost of Capital begins at its current estimated value and then gradually converges to the industry average;
• Initial and Terminal Tax Rate – Given the fact that its recent averages are around the industry average I’ve decided to set it as it is.

All the other inputs were taken from the financial statement or from analyst projections.

The DCF gives us an estimated fair value of 141.18 dollars for Amazon.

Something that we can also do now is to play around with Monte Carlo simulations. What this will allow us to do is to simulate multiple DCF valuations with pre-defined ranges for each of the inputs. Each simulation will randomize the inputs between these pre-defined values. For this I also used analysts estimates.

As you can see from the above Amazon seems to be overvalued given that its current price of 198.22 dollars is above P90. From these simulations we can extrapolate that there’s more than 90% probability of Amazon being overvalued.

Please be free, as before, to fill in your own values. Make the valuation your own and do yourself a DCF valuation using your own assumptions: DCF – The Fair Value Journal

EPS Growth (Weight: 25%)

For this valuation method, I’ve used the current EPS and the analysts estimates of EPS growth. I also assumed a 20 PE for the company.

Then again used the Monte Carlo simulations to check what happens when the input values change within a specified range:

Using this valuation method, Amazon that is currently priced at 198.22 dollars seems to be fairly valued being currently priced very close to the median. From this we can extrapolate that there’s more than 50% probability that the stock is undervalued and 50% probability that the stock is overvalued.

As before, feel free to try this yourself: EPS Growth – The Fair Value Journal

Historical EV/EBITDA (Weight: 15%)

The current EV/EBITDA (Enterprise Value / Earnings Before Interests, Taxes, Depreciation and Amortization) ratio is below its 7-8 Year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical average of 24.02 we can assume a fair value of 248.17 dollars.

For every type of historical and relative valuation you can use the same free tool: Historical / Relative Valuation – The Fair Value Journal

Historical P/CF (Weight: 10%)

The current P/CF (Price / Free Cash Flow) ratio is below its 7-8 Year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical average of 24.03 we can assume a fair value of 236.99 dollars.

Historical P/S (Weight: 5%)

The current P/S (Price / Sales) ratio is above its 7-8 Year average. This means that the company is overvalued by this metric. Assuming a mean reversion to its historical average of 3.23 we can assume a fair value of 172.54 dollars.

Historical P/B (Weight: 2%)

The current P/B (Price / Book) ratio is below its 7-8 Year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical average of 11.92 we can assume a fair value of 284.32 dollars.

✍️Summary

Now that we did all the heavy work, let’s take the above and come up with the company weighted average fair value.

I basically take each valuation method used and given my confidence on the company apply a 20% or 10% discount (when to buy) and addition (when to sell) or use the Monte Carlo P10, P20, P80 and P90 values:

Feel free to choose your own values, but for me I will pick a fair value of 168.12 dollars given the overall moat of the business and the potential opportunities this company may create for itself in the future.

Overall it seems Amazon is overvalued or at least a little overvalued at the current price.

Fair Value: 168.12 dollars